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IT MAY BE, AS OLIVER STONE would have it, that money never sleeps. (See film review,"Wall Street Sequel Falls Flat.") What's certain is that money never waits.
Market prices inherently capture the mood of the most impatient among us, the urge to buy and sell being an explicit refutation of the principle of wait and see.
And so, the market habitually jumps to conclusions, well-grounded or not. The spring-into-summer corrective phase at times had investors extrapolating the European debt drama into a public-sector replay of the 2008 financial meltdown. And traders were a bit quick, it now seems, to turn some U.S. economic slackening into a likely recession relapse.
The widely acknowledged and commonly feared September-October turbulence was over-anticipated, to the point that typically weak September action was pulled forward into August. And, if this four-week rally makes much more headway than it already has before settling back a bit and calming freshly sprung investor enthusiasm, chances are that it will represent the market prematurely offering an all-clear on the economic front.
This natural tendency to shoot first before clearly seeing the target argues against the popular idea that a large pool of investors and business decision-makers is in suspended animation, while awaiting clarity on the mid-term election outcome and future tax policies. But while stocks have performed quite well, on balance, following mid-term elections that reverse the prior election's trend, the market doesn't move the moment that CNN declares the winners. Instead, it either moves before the voting starts (as in 2004 and 2007) or belatedly (as in 1994).
Furthermore, for all the attention directed at whether income, capital-gains and dividend taxes will rise on high earners, taxes simply aren't the prime driver of investment decisions that they are made out to be. Sure, in years when the capital-gains tax was cut, the S&P 500's median one-year gain was 19.5%-plus, well above average, says Ned Davis Research. Yet the sample covers just six years, with five up and one down. In the 13 years when cap-gains rates rose, the median gain was 6.1%, with only two losing years, 1913 and 1969.
If investors are so focused on taxation of dividends, why didn't dividend-paying stocks immediately start to outperform once the Bush cuts on dividend taxes hit in 2002–and why have high-dividend stocks been beating the market in recent months? The latter trend probably relates to just how wide a spread there is between dividend and Treasury yields, but it dilutes the case for taxes as a major swing factor. Finally, if folks are so tax-averse, why has the most popular asset among small investors the past couple of years been corporate bonds–with interest payments taxed at the full income rate?
TO REPEAT A PHRASE employed here a few years ago, today's market pivots from a funeral to a party as fast as a VFW hall.
Just as the depth of despond evident in investor-sentiment gauges around Labor Day was out of proportion to what the market and economy had been doing, the volume of cheer engendered by this four-week, 9% rally looks to be running at least a bit ahead of what has, after all, been a marginal upside exit from a long, grinding trading range.
There's no denying that the tone of trading has greatly improved, in nearly every way aside from the still-unimpressive volume. Earnings forecasts have not yet turned lower for next year in a meaningful way. Until they do, the cosmetic valuations on big stocks remain unchallenging. Based on the persistence of this rally, it would appear that someinvestors feel underexposed to equities.
With the aforementioned rise in bullish opinion and some pockets of speculative action evident, a rest or quick stumble wouldn't be surprising – particularly with some high-stakes data such as the ISM manufacturing index on the way this week, which will now have to hurdle newly inflated expectations. Yet even so, as noisy as the near term might be, a run toward the April highs appears more likely. Meanwhile, the long-term, slow-moving market pendulum is poised to begin swinging in investors' favor, assuming historical patterns aren't entirely obsolete.
The trailing 10-year return for U.S. equities through the first half of this year has been as poor only six previous times since 1835–and the latest decade was worse than any of those others. The subsequent 10-year annualized total return from those earlier low-water marks was 13.3%, notes Bel Air Investment Advisors. Based on the returns the public is now happily accepting from bonds, most folks would probably be ecstatic with half that.
E-mail: michael.santoli@barrons.com
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